Tax reforms and the underground economy: a simulation-based analysis
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This paper studies the effects of several tax reforms in an economy where taxes are partially evaded by means of undeclared work. To this purpose, we consider a two-sector dynamic general equilibrium model calibrated to Italy which explicitly accounts for underground production. We construct various tax reform scenarios, such as ex ante budget-neutral tax shifts from direct to indirect taxes, and tax cuts on labor and business financed by decreases of government spending. Our results indicate that neglecting the existence of the underground sector may lead to severely miscalculating the macroeconomic effects of tax reforms. Further, the dimension of the underground sector is permanently and considerably reduced by changes in the tax mix that diminish the labor tax wedge. Reductions of the business tax prove to be highly expansionary in the presence of a sizable informal sector.
KeywordsDynamic general equilibrium model Underground economy Tax reforms Italy
JEL ClassificationE62 O41 O52
We thank the editor and two anonymous referees for their excellent comments. This paper has also benefited from the comments and suggestions of Amedeo Argentiero, Andrea Costa, Fabio Di Dio, Edgar L. Feige, Giammario Impullitti, Elisabetta Marzano, Libero Monteforte, Alessandra Pelloni, Lorenza Rossi, Emilio Zanetti Chini, seminar participants at the Università degli Studi di Roma “Tor Vergata” and participants at the Shadow Conference 2015, University of Exeter and at the 56th Annual Conference of the Italian Economic Association, Università Parthenope, Naples.
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Conflict of interest
The authors declare that they have no conflict of interest.
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